Deutsche Beteiligungs — Robust exit activity in Q123

DBAG posted a strong NAV TR of 7% during Q123, reaching €33.01 per share (see chart on front page) on the back of a €38.4m pre-tax profit from its investment activity (versus an €11.9m loss in Q122), with portfolio revaluation assisted by both earnings and valuation multiples (see below). Moreover, the fund services segment posted a €3.5m pre-tax profit (slightly down by 4.3% y-o-y, see Exhibit 1). Fund services income increased by 3.9% y-o-y (assisted by higher fees from the most recent buyout funds, DBAG Fund VII and VIII) but this was more than offset by higher expenses. DBAG still guides to a net asset value of €605–675m at end-September 2023 (implying a c 4–16% y-o-y increase), as well as a FY23 pre-tax profit for the fund services segment of €13–15m (versus €15.4m in FY22) and FY23 group net income at €70–80m.

The earnings used to value DBAG’s private portfolio have been rolled over to 2023 budgets (in line with DBAG’s standard practice in the first quarter of each financial year), which was the main driver of the €23.9m positive earnings contribution to DBAG’s portfolio revaluation in Q123 (versus €18.5m in Q122). This means that despite the macroeconomic slowdown in Germany, DBAG expects its portfolio companies in aggregate to improve earnings in 2023 versus 2022. Positive contributions primarily came from broadband telecommunications (15% of portfolio value at end December 2022), industry and industrial technology (36%) and industrial services (11%). Meanwhile, as many of DBAG’s IT services and software companies (20%) were acquired over the last 12 months, they were held at the acquisition price.

The shift in budget year reflected in DBAG’s portfolio valuation is often accompanied by the negative impact of peer multiples (given that the latter are lower in the subsequent year if companies are expected to grow earnings y-o-y). However, in Q123 DBAG booked a €36.5m valuation tailwind from multiples on the back of: a) the rally in public equities in the last quarter of 2022 (the SDAX and MDAX indices appreciated by c 13% and 12%, respectively); and b) recognition of agreed disposal prices (most notably the sale of BTV Multimedia, which contributed c €5m to DBAG’s Q123 net income).

Higher debt lowered portfolio values by €11.3m. DBAG highlighted that many portfolio companies have reduced their debt. While the share of portfolio companies with a net debt to EBITDA ratio above 4.0x fell slightly to 53% at end December 2022 from 58% at end September 2022, it remains well above 17% at end September 2021 (see Exhibit 2). As discussed in our previous note, while some holdings with higher leverage are likely to be from the more resilient ‘growth’ sectors (especially those that performed more add-ons recently), part of the increase in average leverage across the portfolio is likely also due to higher working capital funding requirements and the recent pressure on margins experienced by some industrial holdings caused by cost inflation, supply chain disruptions and project delays, coupled with deteriorating economic conditions last year.

Overall, 19 companies were revalued upwards (adding €54.7m to portfolio value), while 13 were written down (reducing portfolio value by €12.1m).

While FY22 was characterised by DBAG’s high investment activity, FY23 to date has seen notable successful disposal agreements. We consider it a positive given the tough exit environment across the PE sector recently.

In November 2022, DBAG agreed to sell Cloudflight (a full-service provider of industrial digital transformation) to Partners Group, achieving a strong MOIC of more than 4.0x after a holding period of around three years (DBAG will reinvest part of the proceeds in a minority stake in the business). See our previous note for details.

Next, DBAG agreed and completed the disposal of Heytex (a manufacturer of textile print media and technical textiles) to the private equity firm Bencis. This is something we believed was a possible move in our previous note, given that the company was the last unrealised investment of DBAG Fund V with a holding period of 10 years. DBAG’s management highlighted that it was able to achieve a good price for the asset despite its sensitivity to the recent surge in raw materials prices. As a result, the fund achieved an overall MOIC of 2.6x across all of its investments over its lifetime (the fund’s investment period started in 2006).

At the end of December 2022, DBAG also agreed to sell its first investment in Italy, Pmflex, which produces cable protection conduits for electrical cables. DBAG realised a MOIC of more than 2.0x (it invested €11.2m), which we consider attractive given the relatively short holding period (DBAG acquired Pmflex from the company’s founding family in September 2020). Importantly, the company was sold to a strategic investor – Hager Group, which provides solutions and services for electrical installations in residential, commercial and industrial buildings. The agreed price was in line with the last carrying value, hence did not contribute to DBAG’s portfolio revaluation in Q123.

Finally, DBAG agreed to sell its investment in BTV Multimedia in February 2023 (a manufacturer and full-service provider of cable and fibre optic networks) to ETC Group (a strategic French investor), with the disposal price implying a healthy MOIC of c 3.0x. During its holding period (since August 2018), DBAG executed a buy-and-build strategy with five completed add-ons to expand the company’s market presence. Moreover, DBAG highlighted that BTV Multimedia has significantly broadened its product and service range for the expansion of fibre optics networks. Finally, DBAG’s management facilitated smooth succession arrangements for this family-owned business.

During Q123, DBAG also completed the partial sale of GMM Pfaudler (a manufacturer of glass-lined reactors and components for the chemical and pharmaceutical industries). In terms of new investments, DBAG focused on its buy-and-build strategy with four add-on acquisitions agreed during the quarter (three of which closed) on behalf of MTWH, netzkontor and Karl Eugen Fischer.

DBAG’s recently agreed disposals will translate into a solid cash inflow in the high double-digit-million euros, according to management. Proceeds from Cloudflight will amount to €45m (although part will be reinvested), while we calculate that the sale of BTV Multimedia and Pmflex will represent combined gross proceeds of more than €50m. This will provide a significant boost to DBAG’s liquidity position, which at end 2022 stood at €79.2m (of which €18.5m is in financial resources and €60.7m in an undrawn credit line). This compares with DBAG’s total outstanding commitments to invest alongside its funds of €229.2m at end December 2022 and its envisaged medium-term investment pace of c €96m pa on average (based on November 2022 planning).

While DBAG’s reported investment opportunities increased to 51 in Q123 from 44 in Q422, they remain slightly subdued compared to last year (83 opportunities in Q122, see Exhibit 4). Looking at 2022, deal activity across the German mid-market slowed down to 43 deals with a volume of €4.1bn versus 62 and €6.6bn in 2021, respectively (according to DBAG and the FINANCE news service), still ahead of 2012–17 and 2020 levels (see Exhibit 5). It is worth noting the 67% share of primary transactions (ie buyouts from families and founders) in 2022.

Given that DBAG’s fee income broadly covers its ongoing expenses (€43.2m and €40.2m in FY22, respectively), we believe that the exit proceeds from recently agreed deals make a return to its annual dividend payment of €1.60 per share, in line with its medium-term FY23–25 target, likely.

DBAG’s NAV reflects its PE investment portfolio. Having said that, DBAG manages fee-generating third-party assets of close to €2.0bn (AUM including DBAG’s investment portfolio at end December 2022 was €2.6bn). Historically, DBAG’s shares have traded at a premium to NAV (five-year average of 6%), which we believe reflects the market-implied value of the fund services segment (Exhibit 6). Given the 21% decrease in DBAG’s share price since end 2021 to date (despite the recent rebound), reflecting a broader trend in the listed PE space, it currently trades at a 6% discount to NAV. This compares to a 20–40% discount for most peers despite NAV underperformance (3i, which also manages third-party assets and generates fee income, trades close to NAV currently).

We estimate the market-implied value of both DBAG segments for two scenarios: (1) using the implied value of PE investments, assuming fund services are valued in line with peers; and (2) using the implied value of the fund services segment, assuming that PE investments are valued in line with peers. For peers to DBAG’s fund services segment, we use a group1 of listed asset managers with exposure to alternative unlisted assets, such as real assets or PE (as described in detail in our August 2021 note). In the case of PE investments, we use the peer group shown in Exhibit 8, excluding 3i.

Given the higher visibility in terms of income generation in the asset management business, valuation multiples in the sector were less volatile in recent months than the market valuations of listed private equity investment companies. Assuming the fund services segment is valued in line with peers (ie at a 19.4x FY23e earnings multiple), the implied value of DBAG’s PE investments is €310m (ie 50% below its end-December NAV), while DBAG’s peers currently trade at an average 28% discount (excluding 3i, see Exhibit 8).

The wider discount may be at least partially justified by DBAG’s high exposure to the German industrials sector, which has been experiencing market headwinds for a prolonged period, even before the pandemic. We believe this is an important factor behind DBAG’s NAV underperformance versus peers. As at end December 2022, 47% of DBAG’s portfolio is allocated to industry/industrial technology and industrial services sectors (overall, companies from DBAG’s ‘core’ sectors are currently valued at 1.0x acquisition cost).

However, while expectations a few months ago were for a mild recession in Germany in 2023 (see our previous note for details), the outlook seems to have improved recently. This is illustrated for instance by the European Commission (EC) recently revising its real GDP forecast for Germany from a 0.6% contraction to 0.2% growth (after 1.8% growth in 2022). This revision was mainly driven by softening energy prices (assisted by a relatively warm winter, additional gas imports and gas consumption savings) and policy support for households and companies. The EC expects easing energy prices, a gradual adjustment in supply chains, and overall solid corporate finances and full orders books to set the stage for a resumption of investment growth in 2023. Similarly, according to the latest outlook for the German economy for 2023 and 2025 published by Deutsche Bundesbank in December 2022, a gas shortage is unlikely to occur (despite Russia’s ongoing invasion of Ukraine) and the German economy will gradually recover from H223 as foreign demand rises, uncertainty abates, price pressures from energy commodities diminish and the inflation rate falls. Nevertheless, it forecast that real GDP would decline by 0.5% in 2023 and inflation would remain elevated at 7.2% in 2023 (the EC expects 6.3%), although declining from 8.7% in 2022. The EC highlights that corporate margins have been under pressure from a significant rise in producer prices (depressing the outlook for equipment investment), while higher building and borrowing costs will weigh on construction. At the same time, the EC believes that exporters will be able to unwind production backlogs as supply bottlenecks ease and foreign demand improves.

Based on payments in the last 12 months, DBAG’s dividend yield stands at 5.2%, one of the highest among peers. Having said that, DBAG decided to recommend a lower DPS to be paid from FY22 profits to secure liquidity in the current environment, which implies a 2.6% yield, slightly above the median. However, we note that some peers may also reduce dividend payouts this year, illustrated by Princess Private Equity suspending its second interim dividend from FY22 profits (see our note and podcast for details). DBAG intends to return to a €1.6 DPS in the medium term (2023–25).